Investors ready to take legal action

The government was facing fierce resistance from shareholders last night as its plans to nationalise Northern Rock began to take shape.

It is widely expected that the independent valuation of the bank announced by the Treasury yesterday will put the bank's value at rock bottom - causing huge losses for powerful City hedge funds that have gambled on the value of the shares rising, and also incurring losses for thousands of small investors.

The valuer, who will be appointed next week after the bill to nationalise Northern Rock has completed its passage through parliament, will judge whether the government needs to pay anything to buy the bank, after ministers said they would purchase all the shares in the company.

City analysts said yesterday that putting a price on the bank would be difficult given the tumultuous events since September when it almost went bust. On Friday, before its shares were suspended, they were trading at 90p, putting a value on the bank of £380m. At their peak early last year they were trading at £12, making it worth more than £5bn.

Northern Rock's biggest active shareholders are the hedge funds SRM Global and RAB Capital, which together have bought about 20% of the total, some at prices close to 200p a share.

SRM, which is based in Monaco, scooped up most of its holding last October following the bank's rescue by the Bank of England. It could lose more than £60m if the bank is deemed worthless. It has threatened to sue the government if it nationalised and refused to compensate investors at less than 400p per share.

Small shareholders are also agitating for a sale at 400p or more. The Northern Rock Small Shareholders Group reported that all the respondents to its website wanted the government to pay either the value of the bank on the day after it floated on the stock exchange in the late 1990s (452p) or the value on the day after the run on the bank in September last year (438p)

Ministers are unlikely to fear a political backlash for denying the hedge funds a profit, but the 100,000 shareholders with 1,000 or fewer shares will be harder to brush aside. So too will Northern Rock staff, who own 11% of the company. If their holdings are wiped out there could be an emotional weight to claims that the bank has been undervalued.

David Greene of Edwin Coe said that shareholders would claim a breach of human rights and demand payment based on the "proper valuation" of their shares.Greene, who acted for shareholders of Railtrack after its renationalisation, said: "Investors will be seeking appropriate payment from the government".

SRM's boss, Jon Wood, is understood to be considering an injunction to stop the nationalisation. Failing that, he must persuade the high court that 400p is not a fantasy figure, but one based on a fair value for the mortgages and £12bn of deposits.

Most City analysts said the small shareholder coalitions and hedge funds were on a losing wicket. Most investigations of the bank's mortgages show that many are high risk and could almost be described as sub-prime.

The main private sector bidder, Sir Richard Branson's Virgin Group, said the shares were worth only 50p.

One analyst said: "Equity holders may scream and kick, but the government's suggestion that compensation will be assessed on the basis of the likely value of the bank without support seems entirely reasonable to us and suggests a de minimus value. Politically the move to nationalise may be expensive, but economically we think it is the best of a bad job."

Railtrack's shareholders settled for 250p per share, a little less than the 280p when shares were suspended, but well below early claims of about 400p.